One of Morgan
Stanley's investment strategists, Gerard Minack, is retiring.

This is a bummer. Minack's work was lucid and helpful.

But as a parting gift to clients, Minack wrote
a two-page farewell note that contains the best investment
advice you will likely ever receive.

What is this investment advice?

Don't try to pick
stocks

Don't try to time the
market

Just
invest in a portfolio of low-cost, tax-efficient index
funds

Now, before you go scrutinizing Minack's note to find these
bullet points, let me be the first to say that Minack does not
actually explicitly articulate this advice.

Rather, he just demonstrates conclusively why any other
investment strategy is idiotic.

For starters, Minack points out that, in the average year, 60% of
actively managed mutual funds underperform their benchmark.

This means that, in any given year, you have a 40% chance of
picking a fund that will beat the market. So if you try to pick a
fund that will do this, the odds are already against you.

Then Minack notes that, over the 3-year period through 2012, a
staggering 87% of funds lagged the market--a percentage of
failure that is similar to the percentage in most three-year
periods.

This means that, if you plan to hold your investment for 3 or
more years, you have about a 1 in 9 chance of picking a fund that
will beat the market.

Those are truly awful odds.

And it gets worse.

If you are like most people, in addition to trying to pick funds
that will beat the market, you will try to pick times to be in
the market (namely, when you think it's going to go up.) And, if
you're like most people, you will not be able to pick good times
consistently. (On the contrary...) As a result, you will pull
money out of the market when you should be putting it in, and put
money in when you should be pulling it out. And this will further
bludgeon your returns.

If you are like most sophisticated rich investors,
meanwhile, you will think that, by investing in hedge
funds instead of dime-a-dozen mutual funds, you
will have a much better chance of beating the market.

Instead, your chances will actually be much worse.

Why?

Because it turns out that the thing that causes the majority of
funds to lag the market (mutual funds and hedge funds)
is not poor stock-picking ability but fees.

On a gross basis, before subtracting costs and fees, about half
of funds beat the market every year and half of funds lag it.
(This is because funds basically are the market). Once
you subtract costs and fees from both groups, however, the odds
get much worse. And hedge funds generally charge much higher fees
than mutual funds.

If, instead of trying to pick a fund that will beat the market,
and pick times to be in the market, you just buy and hold a
low-cost index fund, you will be guaranteed to beat 90% of
funds over the long haul.

This is because, unlike actively managed funds, index funds have
very low costs and fees. So they track the market, while, on
average, the group of actively managed funds loses ground to
costs and fees.

In contrast to your odds of picking a fund that will beat the
market, having a 100% chance of beating the vast majority of
actively managed funds are excellent odds.

Here's the problem, though:

In my experience, it takes a lot of time to persuade even a smart
person that it is much smarter to buy and hold low-cost tax
efficient index funds than it is to try to beat the market or
time the market.

After I left Wall Street in 2001, for example (I used to be a
stock analyst), it took me about three years of reading Jack
Bogle and the academic research and looking at historical
performance to persuade myself of this. Eventually,
however, the evidence became undeniable and overwhelming. And
then I finally stopped trying to pick stocks and (for the most
part) time the market and moved my own portfolio into index
funds.

This is by far the best investment decision I have ever
made.

Gerard Minack has done Morgan Stanley clients an incredible
service by beginning to explain this reality to them as he
leaves.

Hopefully, Morgan Stanley's financial advisors will now pick up
Minack's torch and place their clients in low-cost tax-efficient
index funds.

(And, if they don't, I would urge Morgan Stanley clients to ask
some hard questions of their Morgan Stanley financial advisors.
It is not a theory that investing in low-cost index
funds is a smarter strategy than trying to pick funds or stocks
and trying to time the market. It is a demonstrable fact. With
very few exceptions, anyone who tells you
otherwise either doesn't know what they are talking about or is
selling something. If you want to read more on this,
I actually
wrote a book about it here.)

Here are some charts that Minack published today that should
start to persuade you of this:

1. On average, 60% of funds lag the market.

Gerard Minack, Morgan Stanley

2. Over longer periods, the percentage of funds that lag
the market is much higher:

Gerard Minack

3. Investors are terrible at market timing. They put
money into the market after stocks have done well for a long
time, and they pull money out when stocks have collapsed.

Gerard Minack, Morgan
Stanley

4. Because investors are lousy at market timing, their
actual returns are far worse than the market returns or the
average fund returns. They sell before funds do well and buy
before they do badly.

Gerard Minack, Morgan
Stanley

5. Hedge funds are terrible, too (mainly because of the
super-high fees).

Gerard Minack, Morgan Stanley

Those are not opinions. They are facts.

Now, if you're like I was ten years ago, you simply won't accept
this. You will think that you can pick the few funds
that will beat the market and that you can time the
market, even if other investors can't.

This belief of yours (or your advisor's) will, in all likelihood,
be very expensive for you, and it won't likely be true. But, if
you're like me, you'll probably have to learn that the hard way.

So, if nothing else, please just consider the possibility that
these charts might be right, that you might not be one
of the handful of investors who can pick great funds and time the
market consistently, and that index funds might actually be a
smart way to go.

Because the sooner you get started in the learning process
necessary to persuade yourself of this, the better your returns
will be.